Foreign play for MFs & locals may blend

MUMBAI: After the curbs on foreign borrowings, Indian policymakers are now set to take recourse to another tool to tackle strong capital inflows. The government and financial sector regulators—RBI and Sebi—are close to finalising a proposal to converge the regulations on overseas investments by locals and mutual funds to encourage outward flow of capital.

The plan is to allow local investors to utilise the $100,000 limit under the liberal remittance scheme (LRS) to invest in equities abroad through mutual funds.

Earlier, under this scheme, individuals could invest in fixed income investment products such as deposits, property and stocks. But the response has been poor. Outflows in 2004 were just $28.3 million and $13 million up to November 2005 as returns in the Indian market are far superior to those of overseas ones.

By providing a window for local investors to invest a substantially higher amount—$100,000 abroad through mutual funds—policy mandarins are hoping that the resultant outflow will make it easier to manage the surge in capital inflows. Higher outflows will reduce the pressure on the monetary policy authority to mop up dollars and then suck out the liquidity created by sale of securities.

Indian individuals are now allowed to invest only rupee resources abroad through mutual fund schemes. This is different from the $100,000 liberal remittance scheme. However, investor appetite here too has been poor, prompting many fund houses to focus only on the local markets.

The government has fixed a limit of $2 billion for overseas investment by mutual funds, besides a ceiling of $1 billion for investments in foreign exchange traded funds.

The finance ministry, RBI and Sebi are in the process of converging the regulations—Fema and Sebi rules on mutual funds—to facilitate greater outward investment, a senior government official said.

Recently, the PM’s Economic Advisory Council had also suggested liberalisation of outflows by removing administrative and procedural impediments. Earlier, the Committee on Fuller Capital Account Convertibility had also made out a case for easing the norms related to investment abroad for individuals.

It suggested a limit of $200,000 for individuals in another five years, saying it is a strong confidence-building measure and will help investors diversify assets. However, the committee did caution that the opening up would have to be well-calibrated.

A decision on the kind of products to be allowed for individual investors and the individual ceiling for each fund house for overseas investment will be taken soon, the official said. Besides, there is the issue of tax treatment to be looked at.

To surmount any potential problems, some fund houses have opted to design their schemes in a way that 65% of the corpus is invested in stocks here while the balance is earmarked for investing in foreign stocks. This will ensure compliance with local tax laws, which provide for exemption from capital gains for investments held for over an year.

But a senior official said there were no tax issues involved. Fund managers and some officials reckon that if the $1,00,000 limit was being used to invest in stocks abroad through the vehicle of mutual funds, it would not mean that they can skirt the issue of capital gains. In the normal course, if an individual were to invest on his or her own, long-term capital gains tax of 20% does apply.

However, the latest policy initiative may not enthuse many fund managers. The CEO of one large fund house said he does not foresee any investor enthusiasm considering the returns on offer in an economy which is projected to grow at close to 9% this fiscal too.